After falling steadily for four quarters, hedge fund liquidations rose again in the first quarter of 2010 with 240 funds closing during the period, according to the HFR Market Microstructure Industry Report by Hedge Fund Research.

Liquidations were disproportionately skewed towards fund of funds, with 102 fund of funds closing in the quarter.

This marks the seventh consecutive quarter in which fund of funds liquidations have exceeded new launches.

Leverage employed by hedge funds has continued to moderate relative to five years ago, with nearly 70 per cent of all funds, which manage 83 per cent of industry capital, using some form of leverage.

In the HFR Special Report: Hedge Fund Leverage, relative value arbitrage and macro strategies commonly employ higher levels of leverage than event driven and equity hedge strategies. Standard leverage metrics vary broadly across the hedge fund industry, with over half of all funds typically employing between one and two times investment capital.

Larger funds typically exhibit a greater usage of leverage, with nearly 30 per cent of all funds greater than USD1bn employing leverage in excess of two times their investment capital.

Indicative of continued pressure from investors for more attractive investment terms, average incentive fees declined by eight basis points to 19.12 per cent in 1Q 2010, the steepest drop since 2Q 2008, although average management fees were unchanged for the quarter at 1.58 per cent.

Performance dispersion between the best and worst deciles of performance narrowed in the less volatile period, with the top decile of all hedge funds returning an average of 15.2 per cent, while the bottom decile lost an average of 8.6 per cent.

“Both investors and fund managers are continuing to exhibit a heightened sensitivity to leverage and risk, even with the benefit of the performance recovery from 2009,” says Ken Heinz, president of HFR. “Managers are employing lower levels of leverage in response to higher realized asset volatility and higher costs of obtaining leverage, as well as investor preference for a less volatile return profile.”